Chapter 1.2. About Blockchain Technology

The blockchain is the technological foundation underneath bitcoin. It’s the bedrock that keeps the bitcoin network running and stable.

Bitcoin was the first major implementation of blockchain technology. Today, it’s the basic technology behind virtually every cryptocurrency.

Blockchain is one of the least-understood aspects of bitcoin and cryptocurrencies in general. Someone might explain intricate details about bitcoin – but they could have no idea how the blockchain works.

In essence Blockchain is a ledger that records all bitcoin transactions. Yes, the core of bitcoin’s technology is just a ledger – just like any accounting ledger, that keeps track of transactions and transaction data.

One of the key distinctions between bitcoin’s blockchain and an ordinary ledger is the fact that bitcoin’s blockchain is distributed. Typically, accounting software stores a ledger in one location on a single computer. With bitcoin, the ledger is distributed across millions of computers worldwide. These computers all agree on maintaining a unified copy of the ledger. A change in one copy of the ledger will be replicated across the network.

What’s the point of a distributed ledger if anyone can change the data on that ledger? Well, that’s where the cryptography of the blockchain comes into effect. Cryptography secures the blockchain, preventing any “bad actors” from taking control of the network or issuing bad transactions.

How Cryptography Secures the Blockchain

The core security of blockchain technology comes from its use of cryptography. Specifically, blockchain uses cryptography to ensure all transactions added to the blockchain are legitimate. In order to add a block of transactions to the blockchain, you’ll first need to solve a cryptographic problem, then post a verifiable solution, or a proof, for everyone else on the network to see and verify.

Here’s it broken down in simplified form.

Your teacher asks the entire class to solve a math problem. That math problem is posted on the board in front of the class. The first student to solve that problem will be paid $10.

The entire class tries to solve the problem. One student quickly writes down an answer and runs up to verify that answer with the teacher. The student’s answer is incorrect and the student is rejected. Then, another student walks up with the correct solution. The teacher verifies the solution, adds the solution to the board for everyone to see, and then rewards the student with $10.

This is how bitcoin works at the most basic level. The bitcoin network relies on providing cryptographic proofs. These cryptographic proofs, or solutions, are difficult to solve but easy to verify. They’re complex mathematical problems that take an enormous amount of computing power to solve. When a solution is found, however, that solution can be easily verified. Other computers can plug that solution into the formula to make sure it’s correct. The miner – like the student in the example above – receives a reward for providing the solution.

Once a solution has been posted and verified, all the transactions in the block are verified. At this point, the miner has verified the transactions within the block can take place. The miner has confirmed that all the bitcoin transactions are coming from wallets with an adequate amount of bitcoin to send. The block of transactions can be added to the chain. This creates a “blockchain” or “chain of blocks”, which we’ll talk about next.

Adding Another Block to the Chain

Bitcoin’s network is built on a blockchain. The blockchain is a chain of blocks linking each transaction to a previous transaction. Anyone can view the blockchain at any time. It’s publicly verifiable. You can use a blockchain explorer to check and verify every bitcoin transaction that has ever taken place – from the infamous $100 million pizza order to mysterious $50 million transfers.

Each “block” on the blockchain consists of a group of transactions. Typically, each block contains about 2,020 transactions. Once a node – a miner – has verified the block of transactions and provided cryptographic proof, the block is added to the blockchain.

These blocks form a chain by nature: each block in the bitcoin blockchain contains around 2,000 transactions, but it also contains a message referencing the previous block and another message referencing the next block. In order for a block to join the blockchain, it must reference both the previous block and the next block. This creates a unified chain of blocks – a blockchain.

Why Blockchain Technology is a Big Deal

Blockchain is a revolutionary technology. However, the world didn’t recognize the value of bitcoin’s blockchain until years after the network launched.

Make no mistake: bitcoin’s blockchain is a huge deal. It introduces a revolutionary concept based on a simple idea. Here’s where the value of the blockchain lies:

Using blockchain, two people can securely exchange money without the need for a centralized intermediary.

That may seem like a basic idea. But it’s not. Think about what happens every time you pay for something.

When you tap your credit card at a retail store, the retailer’s payment processor is verifying your card information, then contacting Visa and asking them to deduct the balance from your available credit, and Visa relays that transaction to yet another third party – your bank.

When you spend cash at a store, you’re just giving someone a piece of paper. That piece of paper gets its value entirely from the government. The US government says a piece of paper with a $20 symbol on it has value, so your $20 bill is accepted across the country.

In both of these situations, you’re relying on a centralized party to verify the value of the transaction. That means the money you own isn’t truly your own: you always need someone else in order to spend, access, and store that money.

With bitcoin, things are different. The blockchain replaces the middleman. The blockchain acts as a payment processor. It also acts as the storage system, allowing users to be their own banks by retaining hold of their private keys.

The lack of a centralized authority is what makes bitcoin significant. You can securely transfer value to another individual. That individual can verify that bitcoin payment on their own, then transfer something back to you. You can complete peer-to-peer transactions in a trust-less environment: even if you don’t know anything about the other transacting party, you can complete the transaction in a secure way. You can avoid the hassle, costs, and inefficiency of dealing with a bank.

In short, the value of blockchain comes from the fact that it makes banks unnecessary.

Benefits of Blockchain Technology

The main benefits of blockchain technology include:

Eliminates the Third Party: Blockchain technology removes the need for a centralized, trusted, third party – like a bank or a government body. Transactions can take place between the two people involved in the transaction. There’s no need for someone to get between the two transacting parties – even when those two parties don’t trust one another.

Lower Fees and Less Friction: By eliminating the centralized third party, blockchain technology can lead to lower fees and less friction. You no longer have to pay enormous exchange rate fees when transferring money, for example. There’s no bank to charge a cut of 2% to 4% of every transaction. There’s no need for a greedy, centralized corporation like PayPal. Cryptocurrencies like bitcoin lead to lower fees and less friction between two transacting parties.

Incorruptible and Secure: Today’s entire financial ecosystem is based on traditional bookkeeping. At the most basic level, this bookkeeping system means individual humans are manually entering information into a ledger – like an Excel document. This is prone to fraud, human error, tampering, and other issues. Bitcoin’s blockchain, meanwhile, is incorruptible. It’s impossible to transfer. The entire system is protected with cryptography, making it impossible for a single bad actor to alter the records. The only way to corrupt the bitcoin network is to gather an enormous amount of computing power and overwhelm the network with a 51% attack. This amount of computing power simply doesn’t exist, which is why bitcoin is so secure.

Scalability: Another genius feature of the bitcoin blockchain is its scalability. The network is designed to scale based on the number of nodes, or miners, on the network. As the demand for bitcoin increases, more nodes are incentivized to join the network, creating constant upward scalability. This is where the Bitcoin Cash (BCH) and Bitcoin Core (BTC) debate comes into effect: BCH promotes on-chain scalability based on the original vision of bitcoin, while BTC is turning to a centralized solution called the Lightning Network, which takes transactions off-chain. Both projects have merit, and it remains to be seen which “fork” will reign supreme as the scalability debate continues to range.

The Future of Blockchain

Blockchain is a revolutionary technology. However, it’s full impact on the world has not yet been seen. Some people think blockchain will fizzle away. Others think it will be the precursor to more powerful technologies – like the telegraph was the precursor to the telephone and global communications.

Today, we’re seeing blockchain-like systems that build off blockchain technology. One of the most promising is direct acyclic graph (DAG) technology. Unlike blockchain, DAG doesn’t connect one specific block to the next specific block. Instead, there’s a graph of interconnected blocks joined together in non-linear fashion.

We don’t know what the future of blockchain holds – but from here, things look very exciting.